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Volume 12, Issue 2, 2012   Federal Reserve Bank of Dallas

Weighing the Costs of Payday Lending Restrictions

The Dallas Fed talks with Kelly D. Edmiston, a senior economist at the Federal Reserve Bank of Kansas City, about his journal article titled “Could Restrictions on Payday Lending Hurt Consumers?”off-site In the article, Edmiston examines payday lending and provides new empirical evidence on how lending restrictions in the industry affect consumers. His analysis shows that restrictions deny some consumers access to credit, limit the ability to maintain formal credit and force residents to sometimes seek even costlier credit alternatives. In his report, Edmiston cautions policymakers about the dangers of unintended consequences when restricting payday lending and recommends that they weigh the potential costs against the potential benefits.

Dallas Fed: Give us a brief overview of your journal article.

Kelly EdmistonEdmiston: Many local, state and federal advocates across the country are calling for tighter restrictions on payday lending. I just wanted to provide a more balanced picture of what happens when payday lending is restricted. I did not make an evaluation on whether to limit payday lending. I’m just providing more information on what the outcomes have been across jurisdictions when restrictions are placed.

Dallas Fed: What were your key findings?

Edmiston: In states with strong restrictions (for example, Arkansas, Ohio, South Carolina), I should have seen large increases in the use of traditional credit once the restrictions came to be, but I did not. In other words, there was no real evidence that people were substituting payday lending with traditional forms of credit, like bank or credit union accounts and loans. This finding supports that people who don’t have access to payday credit are not seeking new traditional forms of credit. They are seeking other forms of alternative credit (friends and family) or are adding debt to existing forms or have simply lost access to credit altogether.

Our study also found that people with payday loans held more traditional debt, like debt from credit cards. In states where payday loans are not available or are severely restricted by laws, we found that people had lower credit scores. When faced with unanticipated changes in income or expenses, a borrower may be forced to miss loan payments, default on a loan or bounce a check.

Dallas Fed: What were your data sources?

Edmiston: I used credit union data aggregated at the county level. They obviously don’t collect payday lending data, but I did look at the use of traditional forms of credit and compared it between states with harsh restrictions and those without.

Dallas Fed: What has been the reaction to the article?

Edmiston: There has been some negative reaction from consumer advocates who are focused on eliminating or restricting payday lending. This is not a pro-payday lending article; the results reveal that there can be some access-to-credit issues or unintended consequences. The study, I hope, reveals that we need to start thinking about alternative forms of credit, if a state or local jurisdiction eliminates payday lending.

Dallas Fed: Do Americans truly understand the costs of payday lending?

Edmiston: There is no question that the payday lending business model of marketing the loans does not always register with consumers. It is posed more like a $15 fee for $100 of loan. However, when you state it to be a 390 percent APR [annual percentage rate] loan, as consumer advocates pose it to be, it sounds more predatory in scope. However, to be fair, surveys consistently reveal that consumers of payday loans are happy with their loan. Unfortunately, the payday lending industry business model is really predicated on the repeat borrowers who roll over the loans—and a debt cycle begins. It’s a double-edged sword.

Dallas Fed: What advice do you have for consumer advocates who are trying to regulate payday lenders?

Edmiston: Caps on fees and interest rates too often have the intended consequence of running the payday lenders out of the jurisdiction. Payday lenders cannot operate within small margins because their operating costs and loan loss reserves can be high. Not everyone has access to the alternative forms of credit like friends and family, credit cards and employee-based lending models. So the fundamental question becomes, how do we get people access to affordable credit? This becomes a problem that should be addressed by policymakers before moving forward with restrictions.

e-Perspectives, Volume 12, Issue 2, 2012

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